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Economics "Ask the Instructor" Clip 28 Transcript
Why might the economy’s aggregate supply curve take on different shapes
during different time periods?
As you already know from your reading, the economy’s aggregate supply curve shows the
relationship between the quantity of real GDP produced and the overall price level. Keynes hypothesized
that the aggregate supply curve was essentially horizontal in the short-run, suggesting that the economy
could expand its rate of output without any upward pressure on the price level. In addition, there is
evidence that there are times when the aggregate supply curve would be fairly flat over a period of months,
or even a few years. But, when looked at over a period of many years, there is evidence that the aggregate
supply curve is essentially vertical, suggesting that there is no relationship between the price level and
output. Which of these stories (or theories) are we to believe? The best answer may be that either of them
can be true, at least under certain conditions.
Consider, for example, the 1930s. You’re familiar with the situation. The economy was mired in
a deep economic depression. The unemployment rate was approximately five times higher than today’s.
Moreover, there were few, if any, societal “safety net” programs, like unemployment insurance.
Given the large amount of unused capacity during the 30s, which aggregate supply curve would
be most descriptive of the time? Would it be vertical, upward sloping, or horizontal? Well, the right
answer is horizontal. This shape suggests that there is plenty of room for real GDP to grow without any
upward pressure on the price level. In fact if you were to graph the relationship that existed during the
depression years between real GDP and the price level it would be essentially a horizontal line.
What about the economy in the mid-90s? The unemployment rate varied between 4.5% and 7.5%.
This was neither real high nor real low. The rate had been lower than this in the 60s suggesting that the rate
could be even lower. Thus, there was reason to believe that there was some unused production capacity in
the mid-90s, but not a great deal.
This suggests that any major increase in aggregate demand would likely tend to increase wages
and prices along with output. Thus, many economists would say that an upward sloping aggregate supply
curve would be descriptive of the early- to- mid-90s time frame.
Finally, there is the view that the aggregate supply curve is vertical. This view is the basis for the
conclusion that over a long time horizon, the level of aggregate demand is unimportant. The economy’s
performance depends, in the longrun, only on supply-side factors such as technology, taxes, resource
availability, and institutional factors like customs, laws, and holidays.
In summary, economists do not always agree on the shape that the aggregate supply curve takes in
every situation or every time period. However, most economists do agree that, given sufficient time for all
economic agents to adjust and adapt their expectations, the economy’s output is basically supply-side
determined. This is just another way of saying that most economists view the aggregate supply curve as
essentially vertical in the longrun. This has important policy implications as you will see when fiscal and
monetary policy are discussed.